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Think of a trust as a holding pen, a place where you put your assets before they are released to the people or organizations that you designate to eventually receive them. A trust is a legal entity and so are you. Because you and the trust are separate legal entities, anything you transfer from you to the trust becomes property of the trust. The trust then holds the property for your benefit, or for the benefit of those whom you designate.
A trust consists of four components:
- The grantor, who creates the trust.
- The beneficiaries, who receive the benefits (income and/or principal) of the trust. The grantor can also be a beneficiary.
- The assets, which are the properties transferred to the trust.
- The trustee, who is the person or entity that manages the trust's assets and distributes the property according to terms established by the grantor. The grantor can also be the trustee, at least while the grantor is alive.
Trusts can be set up while you are alive (the legal term for this is intervivos), or they can be established upon your death by your Will (known as testamentary). Revocable trusts can be changed or revoked by the grantor. Irrevocable trusts cannot be changed after they are created.
A multi-millionaire may be a grantor, a retired factory worker may be a grantor, you may be a grantor. Anyone wishing to set up a trust, and transfer his or her assets to that trust is known as the grantor of that trust. The grantor may also be a beneficiary, and the grantor may also be the trustee.
Just as they are in a Will, the beneficiaries of a trust are those who receive the income and/or property of the trust. All property transferred to the trust will be distributed eventually to the beneficiaries.
Testamentary trusts can be established in your Will to come into existence at the time of your death and then administered. A popular testamentary trust is a trust established for minor children, but only if neither parent survives. The trustee will administer this trust to meet your child's financial needs.
Trusts may also be established to fund education costs for grandchildren.
Spouses often are the beneficiaries of trusts. Trusts established to regulate the amount, control, and circumstances of distribution are common. Spouses' needs and situations can change over the years, and having specific limitations on the distribution of the trust assets may prove beneficial.
Beneficiaries of trusts are not always human beings. Charitable trusts are often established to provide annual distributions to a worthy cause of your choosing.
Plenty of work goes into setting up a trust, but the work is not finished until the (intervivos) trust is funded with your assets. The benefits of the trust will only apply to those assets which are actually transferred into it, which means retitling your assets into the name of the trust. This process can take plenty of time and money. Bank accounts, stock portfolios real estate and even business interests need to be changed from your name to the name of the trust.
But not all assets belong in the trust. You should not transfer any tax-deferred retirement accounts because such a transfer will be treated as a taxable distribution and may even be subject to a 10% penalty. Furthermore, the trust should not be the owner of a life insurance policy on your life if your estate might be worth more than $625,000 at your death. There are also personal and emotional reasons why you may want to keep certain assets, such as jewelry or keepsakes, out of the trust. However, don't overlook the possibility that your survivors may have to probate your estate just to be able to distribute assets that were left out of the trust.
You should always create a Pour-over Will to accompany an intervivos, revocable trust, which will pour these assets over into your trust at the time of your death, if necessary.
The person or organization responsible for managing the trust, is the trustee. The trustee can be a friend or relative, a hired third party, or the grantor himself/herself.
In many cases the grantor acts as the trustee during his or her lifetime, at least while he or she is able and willing. Husbands and wives may decide to establish themselves as co-trustees, serving together until one dies or is no longer able to serve, and then the surviving spouse continues as trustee, now serving alone to administer the departed spouse's trust. It is also necessary to name a successor trustee to take over for the initial trustee or co-trustees, often upon the death the grantor. The successor trustee performs many of the duties similar to the executor of a Will. It may also be necessary for the successor trustee to take over when the grantor/trustee becomes ill, disabled, or mentally incompetent.
If your estate is not large, it is common to name a friend or relative as the successor trustee. Many times a friend or relative may waive the trustee's fees. However, for large estates many grantors prefer to hire a trustee from a bank's trust department. A professional trustee possesses business skills that may be necessary in dealing with large estates, he or she is emotionally unattached to the trust, and a professional trustee is immortal.
What is a Living Trust?
A Will comes into play only after you die, but a living trust can actually start benefiting you while you are still alive. A living trust is a trust established during your lifetime. It is revocable, which allows for you to make changes. You will transfer substantially all of your property into your living trust during your lifetime, and any omitted assets can be transferred into the trust at the time of death through the use of a simple Pour-over Will. You should always make a Pour-over Will at the time that you establish your trust.
A living trust will be used as the mechanism to manage your property before and after your death, as well as provide how those assets, and the income earned by the trust, are distributed after your death. If you should become incapacitated or disabled, the trust is in place to manage your financial affairs, usually by a successor trustee, if you were serving as trustee. A living trust is not subject to probate, and therefore, all provisions of the trust will remain private.
Joint living trusts are also possible. They simply combine the assets of a husband and wife into a single trust, governed by a single trust document. However, if estate tax minimization is important (for combined estates which will exceed $625,000), the joint living trust must be very carefully drafted with the help of an attorney in order to achieve the desired goals.
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Benefits of a Living Trust
A living trust can be useful to:
- avoid probate in your own state, and especially in other states where you also own property,
- preserve privacy
- establish a mechanism to manage your property if you become incompetent, and
- make it harder for family members to challenge your distribution wishes (compared to a Will).
However, a living trust is not for everyone. If avoiding probate is one of your primary reasons for establishing a living trust, it's essential that all of your assets be placed into the trust. If any are missed, it may be necessary to probate the estate in order to transfer the few excluded assets. Also, titling all of the property in the name of the estate can be cumbersome and it becomes an issue whenever you buy or sell property.
Residency issues also are a factor in choosing a living trust instead of a Will. Many states will not allow non-residents to serve as the executor of an estate, but they will allow an out-of-state trustee of a living trust to serve.
Tax Consequences for Spouses
Using a living trust does not provide any advantages over the use of a traditional Will in saving estate taxes. However, under either method-living trust or traditional Will - one or more of a different type of trust can be established that will minimize estate taxes and/or control the distribution of property beyond the life of the surviving spouse. For example, a credit shelter trust (also referred to as a credit trust, bypass trust, B-trust or Family Trust) is set up to minimize estate taxes; a marital trust (also referred to as an A-trust, and which could also be a QTIP trust or a power-of-appointment trust or a disclaimer trust) may be established to obtain estate tax advantages, provide for the surviving spouse while alive, and direct the disposition of the assets after the death of the surviving spouse.